‘Transitional’ IBM faces growth slowdown

Q2s display a curate's egg of a company

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IBM CEO Lou Gerstner recognised at the announcement of IBM's Q2 results last night that "In a portfolio of our size, we often have units in transition", and so it proved. IBM is in effect a conglomerate of companies, each with a different business cycle, so it is difficult for the company to do well as a whole unless the business cycles largely coincide. So far they haven't, and for the last three quarters, there has been slow revenue growth.

Yesterday's Q2 results were at least a win for IBM over the financial analysts, who had predicted $1 earnings per share, but in the event IBM turned in $1.06. Total revenue was $9.151 billion for Q2, down 1.2 per cent on a year ago, with net income at $1.841 billion. Comparison with the year-earlier quarter is difficult since IBM sold its Global Network to AT&T during that quarter, gaining 37 cents per diluted share on the transaction. IBM attributes the slowness to Y2K woes and actions taken to improve its business portfolio.

Geographically, year-on-year at constant currency, the Americas were down 3 per cent, EMEA was flat, Asia Pacific was up 13 per cent, and OEM was down 7 per cent.

It seemed just a few months ago that Global Services was hitting the buffers after a very good run, but half way through the quarter, there was re-ignition resulting in new signings for the quarter of $20.3 billion. Of these, twenty were for more than $100 million, and three for more than $1 billion. The contract backlog is a healthy $75 billion.

Software revenue was up 2 per cent compared with the year-earlier quarter (and would have been up 5 per cent if it hadn't been for those pesky currency undulations, mostly caused by eurozone problems). At constant currency, there was an 11 per cent increase in middleware sales, with UNIX/NT up 34 per cent (but unfortunately not broken down), and S/390 software up 3 per cent.

WebSphere is poised to take the lead, having seen 200 per cent year-on-year growth, and will be getting a $1 billion investment to help it along. Operating system revenue was down as a result of lower AS/400 sales, although new models could soon reverse this.

The PC business revenue declined, partly because of component shortages (IBM admitted earlier this week that 79 of its 108 ThinkPad configurations were back ordered), but IBM is still confident that it will break through to profitability later this year, largely thanks to an increasing volume of direct sales and better margins. Q2 saw an improvement of $100 million, largely attributable to direct sales increasing to 24 percent year-on-year, and up 5 per cent on with the previous quarter, to nearly $1 billion in total: the proportion of direct sales is expected to grow to 35 per cent by the end of the year. There's some way to go before IBM out-Dells Dell, but the old war horse has learnt a few tricks, it seems.

Other hardware business is still mired, and declined 5 per cent. Web servers revenue grew 30 per cent, but both S/390 and AS/400 revenue declined, which IBM attributed to lowered prices for S/390 and product transition for AS/400. Against the expectations of many observers who had predicted the demise of the mainframe (even if we do call them servers nowadays), S/390 MIPS grew a little after three quarters of decline, fuelled by e-business demand.

Microelectronics revenue was up, but storage revenues were down. IBM has become the leader in custom logic, which was up 33 per cent.

IBM has been getting some stick for its level of indebtedness, but there is only $2.5 billion of core debt outside the $26.7 billion that IBM borrows for its profitable global finance operations, in order that shareholders do not take a hit for this. IBM currently has $3.3 billion in cash, down from $7.2 billion a year ago. Share repurchases were $1.8 billion during the quarter, with 1,768 million now outstanding.

CFO John Joyce was bullish about the next two quarters, with the market rewarding the company by pushing the share price up in after-hours trading by 5.5 per cent, to $108.75. IBM's e-business strategy does seem to be working, but questions need to be asked as to whether it would not do even better if there the company were split into separate companies, so that Gerstner's "units in transition" syndrome does not keep dragging down the whole company. IBM still has vast tiers of bureaucracy and fiefdom in-fighting that could be easily removed if the company were carved up. Although it is no longer fashionable in IBM circles to speak of shareholder benefit from a breakup, unless the company can deliver the double-digit growth promised by Joyce before the end of the year, it is inevitable that more shareholders will start agitating for it. ®